First Horizon National Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; filed August 7, 2018. First Horizon is a regional banking and fixed-income financial services company. Results include Capital Bank Financial (CBF), acquired November 30, 2017, so year-over-year comparisons reflect a materially larger company.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $310.9m | $200.7m | $612.1m | $390.4m |
| Noninterest income | $127.5m | $127.7m | $263.5m | $244.6m |
| Total revenue (net interest income plus noninterest income) | $438.5m | $328.4m | $875.6m | $635.0m |
| Noninterest expense | $332.8m | $217.9m | $646.0m | $440.1m |
| Net income | $86.0m | $95.2m | $181.0m | $153.6m |
| Net income available to common shareholders | $81.6m | $90.8m | $172.2m | $144.8m |
| Diluted earnings per share | $0.25 | $0.38 | $0.52 | $0.61 |
| Net interest margin | 3.53% | 3.07% | 3.48% | 3.00% |
Quarterly common earnings fell despite higher revenue, as expenses rose faster. First-half common earnings increased, while diluted EPS declined because of the additional shares issued for the CBF acquisition. Management attributed revenue growth principally to CBF-related balances, loan growth, higher rates and loan accretion. Fixed-income revenue declined amid challenging market conditions.
- Returns: Q2 ROA was 0.86% versus 1.32%; ROE was 7.86% versus 15.26%. First-half ROA was 0.91% versus 1.07%; ROE was 8.32% versus 12.38%. Acquisition and integration costs weighed on returns.
- Credit: Q2 provision for loan losses was zero, compared with a $2.0m provision credit a year earlier. First-half provision was a $1.0m credit versus a $3.0m credit. Net charge-offs were $1.7m in Q2; allowance for loan losses was $185.5m, or 0.67% of loans, at June 30.
Financial position, liquidity and capital
- At June 30, total assets were $41.1b, total loans net of allowance were $27.5b, deposits were $31.0b, total liabilities were $36.5b and total equity was $4.5b. Loans were nearly unchanged from December 31, 2017; deposits rose from $30.6b.
- Cash and cash equivalents were $1.48b and interest-bearing cash was $0.75b. For the first half, operating cash flow was $43.9m, investing cash flow was $428.9m, financing cash flow was negative $447.8m, and cash and cash equivalents increased $25.0m to $1.48b.
- Period-end short-term funding included $351.7m federal funds purchased, $713.2m repurchase agreements, $743.7m trading liabilities and $1.84b other short-term borrowings; term borrowings were $1.23b. Other short-term borrowings declined from $2.63b at year-end.
- Regulatory capital ratios at June 30 were 8.98% common equity Tier 1, 9.98% Tier 1, 11.25% total capital and 8.56% Tier 1 leverage. The company and bank met well-capitalized thresholds. FHN reported $1.5b of additional FHLB borrowing capacity.
- First-half dividends declared were $0.24 per common share. The board had authorized a $250m common-share repurchase program; no purchases had been made under that authority by June 30.
Material changes and unusual items
- CBF added approximately $9.9b of assets, including $7.3b of loans, and $8.1b of deposits. The acquisition resulted in approximately $1.2b of preliminary goodwill. Integration activities were substantially completed in Q2; related expenses were $41.8m for the quarter and $71.9m for the first half.
- CBF dissenters’ shares were canceled in Q2, reducing equity consideration and increasing estimated cash consideration by $46.0m. The final appraisal or settlement amount remains uncertain.
- FHN sold about $120m of acquired subprime auto loans in Q2 because they did not fit its risk profile. It also divested two branches, approximately $30m of deposits and $2m of loans, under commitments related to the CBF merger review.
- Q2 AFS securities unrealized losses were $21.1m after tax; first-half other comprehensive loss was $89.1m, largely reflecting higher-rate-related securities losses. AOCI stood at negative $412.1m at June 30.
- FHN adopted several accounting standards in 2018, including the standard moving equity-security valuation changes into earnings; management reported no significant adoption impact on revenue timing. The filing says the expected effect of the forthcoming credit-loss standard was still being evaluated.
Outlook, risks and contingencies
- Management described the balance sheet as moderately asset-sensitive. Its simulation estimated NII increases of 0.9% to 6.1% under rate shocks of +25 to +200 basis points, but decreases of 0.4% and 2.2% under shocks of −25 and −50 basis points. These are model scenarios, not earnings guidance. Faster deposit-cost increases, a flatter yield curve or falling rates could reduce the benefit.
- Management expected near-term asset quality to remain relatively stable if economic growth continued. It cautioned that CRE oversupply, economic uncertainty, unemployment and housing-market weakness could affect credit performance; shrinking legacy portfolios can also make asset-quality ratios less representative. No specific full-year earnings guidance is provided in the supplied filing text.
- Legacy mortgage matters remain a material uncertainty. The company reported $41.3m of established liabilities for material loss-contingency matters and estimated reasonably possible losses above those liabilities of up to approximately $21m in aggregate; outcomes could exceed estimates. Separately, repurchase and foreclosure reserves were $32.9m, and the active mortgage-claims pipeline was $12.0m.
- FHN disputes a $43.5m indemnification demand from a former subservicer; the matter could result in litigation. Additional mortgage-related indemnity notices, including from Nationstar and JPMorgan Chase, had no estimable loss range in the filing. Visa-related derivative liabilities were $9.4m; the outcome and timing of Visa covered litigation remain uncertain.
- FHN voluntarily performed stress tests after legislation effectively exempted it and its bank from Dodd-Frank stress-testing requirements; management said results showed capital well above adequately capitalized standards in the severe scenario. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of revenue and earnings growth is recurring and organic versus attributable to CBF acquisition balances, loan accretion and integration effects.
- Whether integration costs decline as expected, and the final cash cost of the CBF dissenters’ appraisal process.
- Deposit pricing, funding mix and net interest margin as rates and competitive pressures change.
- Credit trends in consumer real estate, credit card and other loans, CRE, and finance-company/mortgage-company exposures; also the expected impact of the future credit-loss standard.
- Developments in legacy mortgage litigation and indemnity claims, including whether additional losses exceed recorded reserves and disclosed estimates.
- Changes in AOCI, regulatory capital, liquidity sources and share repurchases or dividends.